Rates squared

Pricing and risk-managing modern exotic interest rate derivatives requires an interest rate model that has a rich volatility structure, multiple sources of randomness, ability to calibrate to a large/complete set of vanilla options (swaptions and caps) and the ability to control volatility smile and rate decorrelation. In recent years, Libor market models have emerged as a clear favourite for the task. While these models satisfy all the criteria listed above, they do have one practical

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